Choice simplification: A theory of mental budgeting and naive diversification

Botond Koszegi, Filip Matějka

Research output: Contribution to journalReview Articlepeer-review

Abstract (may include machine translation)

We develop a theory of how an agent makes basic multiproduct consumption decisions in the presence of taste, consumption opportunity, and price shocks that are costly to attend to. We establish that the agent often simplifies her choices by restricting attention to a few important considerations, which depend on the decision at hand and affect her consumption patterns in specificways. If the agent's problem is to choose the consumption levels of many goods with different degrees of substitutability, then she may create mental budgets for more substitutable products (e.g., entertainment). In some situations, it is optimal to specify budgets in terms of consumption quantities, but when most products have an abundance of substitutes, specifying budgets in terms of nominal spending tends to be optimal. If the goods are complements, in contrast, then the agent may-consistent with naive diversification-choose a fixed, unconsidered mix of products. And if the agent's problem is to choose one of multiple products to fulfill a given consumption need (e.g., for gasoline or a bed), then it is often optimal for her to allocate a fixed sum for the need. JEL Codes: D01, D11, D14.

Original languageEnglish
Pages (from-to)1153-1207
Number of pages55
JournalQuarterly Journal of Economics
Volume135
Issue number2
DOIs
StatePublished - 1 May 2020
Externally publishedYes

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